As you might expect with the cost of real estate in the GTA, most of our buyer clients have a mortgage for a portion of the purchase price.  Depending on their situation it can range from as much as 95% of the purchase price to half or less.

Bank data suggest that about one‑fifth of home purchases are all‑cash and consumer surveys and industry estimates place the share of cash‑offer transactions in the broader range of 15–25 %. In the Toronto area, the percentage of purchases made entirely in cash has climbed into the low 20s and we’d estimate for the GTA that roughly one in five buyers pay for a property with no mortgage.

While lenders in Canada have done very well loaning money to people to buy real estate, it doesn’t mean they don’t follow some rules to make sure the property being purchased is worth the amount the buyer is asking to borrow.

Lenders use appraisers for this purpose, individuals who are trained and accredited in the ability to assess the value of real estate.  While we wouldn’t go so far as to see appraisers are the natural enemies of real estate agents, it can be a difficult relationship.  Real estate agents work in real time on the ground with their clients and have a current and up to date understanding of the market and the value of homes.  Appraisers work from closed deals only and in a fast moving market (with prices either going up or down over the course of weeks), the appraised value they come up with can make the deal price seem wrong.

In addition, while appraisals are often described in scientific terms as if they are concrete, absolute statements of fact, they are more of an art than a science.  Three different appraisers will provide three different values for a given property, sometimes with significantly different valuations.  When was the last time you saw a scientific experiment or theory accepted as valid when the results keep changing?

When an appraisal comes in at higher than the purchase price, it generally doesn’t cause problems.  The buyer is thrilled at the idea that they actually got a bargain on the home, the lender has no issues with proceeding with the mortgage at the agreed upon ratios and everything moves forward.

When the opposite happens, then things can get messy.  Let’s talk about what happens when someone buys a home and the appraisal from the lender comes in at less than what they agreed to pay.

First, the basics.

A buyer submits an offer for a property at a price they are willing to pay. By definition, this is now market value, as the home went up for sale (on “the market”) and a buyer offered a purchase price that the seller accepted. Boom, market value established.

If the buyer has all the money for the property, then that’s it. As discussed though, most buyers have a mortgage of some amount, though, and this is where things get a bit more complicated.

A lender (be it a bank, credit union, private lender or your Aunt Sally) makes the decision to lend based on how much you make, how much you owe and your past record of borrowing responsibility. When we work with clients, we guide them through this process before we get too far along in the purchase journey. By providing job documentation, bank information and submitting to a credit history review, our clients are pre‑approved for a certain amount at a certain interest rate. A pre‑approval can be looked at as the lender saying, “OK, I’m comfortable loaning you this much money based on your situation.”

When a prospective buyer finds the home that fits their needs and budget, we negotiate the best price and terms possible and buy the home. If we can, we write the offer conditional upon financing approval. In a strong seller’s market, it can be very challenging to buy a home with any conditions, but in any market the logic remains the same.  We want financing approval because the buyer needs to turn their pre‑approval in general terms into approval of a specific property.

Here’s an example.

Our client buys a home listed at $729,900 for $800,000 in multiple offers. While we would have preferred to have a financing condition in place, with other offers in play that had no conditions, our client made the decision to remove the financing condition. They had a pre‑approval up to $900K in place and had a down payment of $160,000 ready. This meant they had 20% of the purchase price and wouldn’t need to pay CMHC fees.

Though our client is willing to pay $800K for the property and has been pre‑approved for up to $900K in a general sense (based on income, debt levels and credit history), the lender must be comfortable that the property is worth that $800K. In essence, the lender needs to be confident that when it comes time to sell the property and recover their loaned amount (the outstanding mortgage due), they will be able to get their full amount back.

The lender sends in the appraiser and in a few days comes back with some bad news: the property that our client has bought firm for $800K is appraised at $750K, a shortfall of $50K.

Our client expected the purchase would look like this:

• Purchase price: $800K
• Mortgage: $640K (80% of $800K)
• Down payment: $160K

After the appraisal comes in lower than the purchase price, the lender says, in effect, “We were willing to loan you 80% of the purchase price, with you providing a 20% down payment. We are still willing to loan you 80% of the appraised value, but you need to come up with the shortfall.”

The purchase now looks like this:

• Purchase price: $800K
• Mortgage: $600K (80% of $750K)
• Down payment: $200K

As a result of the appraisal value, our client needs to find an extra $40K in order to close on the deal.

They may be able to find another lender to offer that $40K at a higher interest rate (as second mortgages are second in line after the primary lender for repayment and are therefore riskier) but it will depend on what the changed interest rate does to their debt‑servicing ratio. If they were already at their limit, then finding another lender may be difficult or impossible.

When a buyer has made a firm purchase of a property and runs into financing problems, it is possible that the deal won’t close. If the buyer can’t get the money to close on the closing date, then the seller won’t hand over the keys. To be clear, the buyer has a legal obligation to close on the deal as per the agreed‑upon terms. A legal obligation isn’t the same as actually having the money, though.

The deposit that was provided at or shortly after the purchase date (when the price was agreed upon and the papers signed) is held by the seller’s real estate brokerage. If the buyer cannot close on the deal, then the seller has the option of showing damages and keeping some or all of the deposit that the buyer provided. Determining damages can be complex and lawyers will be involved on both sides to determine if and how much of the deposit can be kept by the seller as a result of the buyer failing to close as they are legally obligated to do.

That sounds…messy.

It’s a messy situation and one that should be avoided at all costs. It truly is something neither side wants, as both the buyer and seller wanted to do the transaction and agreed upon terms that one side ended up not being able to complete.

Here’s how we work for our clients to avoid a situation like this.

When we work with buyers, we discuss the repercussions of a lower appraisal, changes in interest rates and other factors. If we are in a situation where we cannot have a financing condition, we make sure we have done our work beforehand to know the consequences of a lower appraisal and that the buyers have the ability to make up the shortfall if need be. We leverage this information with the seller and their agent, letting them know that our clients are solid purchasers who can close even if the appraisal value is lower. We’ve used this to get a seller to choose our clients over a higher offer price because the seller was more confident we would close without an issue.

On the selling side, we ask questions of the buyer and their agent to get at their situation with regard to financing. We want to know their down payment amount available, income and type of work, and their pre‑approval status. This is true regardless of whether the buyer includes a financing condition. While our seller may have recourse if the deal doesn’t close, our goal is to make sure that from offer to close we have a smooth process.

If you or someone you care about is considering buying or selling, make sure you work with a Realtor that understands how to make sure the deal actually closes. From the day of negotiations to the day the keys are exchanged, we’ll help you avoid surprises.  If that sounds appealing, get in touch with us!

Any homeowner who has bought a home to live in that also has an income suite in it knows it can have a huge impact on the affordability of the home.  While income suites take away some of the space in the house that could otherwise be used by you, the cashflows that come in with the renting of the space change your carrying costs considerably.

Let’s review some key points and then consider an example.

Most Lenders Take Rental Income at 50%…

If you’re looking at buying a home with an income suite, the good news is that the income from renting the suite increases your income in the eyes of a mortgage lender.  If there is a tenant already in place at the home, paying $1,500 a month, that’s $18,000 in annual income.

The bad news is that most lenders discount that rent, often at 50%, in order to account for vacancy.  Unlike a salary, lenders are concerned that the rental income won’t always be there and while it does allow you to increase your approved mortgage amount by some, don’t count on the full 100%.  A good mortgage broker might be able to find you a lender who will take 75% of the rental income, but expect it to be discounted by some amount.

… but the Cashflow is absolutely 100%.

Regardless of how a lender looks at the rental income, when you have a tenant, you are absolutely getting the full amount of rent they pay deposited into your bank each month.

With current mortgage rates (1.99% for a fixed, five year term, amortized over 25 years), every $100,000 in mortgage costs you about $425 per month.  If you’re considering buying a home with an income suite or two, you can figure out how much of your mortgage can be paid by the rental income by dividing it by $425 and multiplying it by $100,000.

• $1,000 per month from a basement suite? That rent pays for $236,000 worth of your mortgage.
• $1,500 per month from a bigger, nicer basement suite? Now $353,000 of your mortgage is covered.
• $2,500 per month from the other half of the duplex you just bought? Congratulations, that rent pays for $589,000 worth of your mortgage.

There are two ways of looking at the impact of your rental income and both are pretty great.

First, when you do the math like above, you can consider the mortgage amount that the rent pays to effectively be a discount on the home.  After all, if you buy a home with $1,500 in rental income, you’re going to paying the same each month as a home that costs $353,000 less.  In exchange for giving up some of your home’s space until you want it for yourself and your family, you are getting a heck of a discount on the effective price of the home.

The second way to look at it is that the rental income means your home cashflows the same as a home that costs $353,000 more.  You can buy a home for $1.2M with no rental income, or a home for $1.5M with $1,500 in rental income and it costs you the same on a monthly basis once you add the rental income into the equation.

If one income suite is good…two are even better.

Let’s go over an example of a listing our team has coming out shortly.

144 Quebec Avenue is a massive (over 2,700 sf above grade, plus another 900 sf of finished basement) detached home just north of High Park.  The home has five bedrooms, four full washrooms, a detached garage accessed by a back laneway, two upper level decks and a backyard patio oasis.  It has absolutely everything you need in a home.

The home is zoned as a triplex and it is currently configured with the owner suite on the main floor and basement, and two updated, attractive income suites.   The one on the 2^nd floor brings in $1,325 in rental income (and that is actually below market rates) and the 3^rd floor unit brings in $1,500 per month.  That’s $2,825 per month in rental income and it could easily be over $3,000 when the rent for the 2^nd floor is brought up to market rates.

With current mortgage rates (1.99% for a fixed, five year term, amortized over 25 years), the $2,825 in rental income pays for over $650,000 of the mortgage.  Let that sink in for a moment.  $650K.  If we look at it from the other perspective, this home cashflows the same as a home that costs $650,000 more.  You can buy it, or a home that costs over half a million dollars more, and your monthly mortgage costs are going to be the same.

Check out the virtual tour here or by clicking on the house below.  If you or someone you know loves the idea of buying a massive home at what is effectively a massive discount, let us know and we’ll arrange a showing.

While being a landlord isn’t for everyone, there are absolutely huge benefits to having an income suite in your home.  If you like the idea of effectively getting a huge a discount on a home, get in touch with us so we can help!